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There are three areas of financial management in which a business needs to have effective procedures when managing the supplier/customer relationship:
- Generating source documents to evidence financial transactions between the supplier and its customer.
- Having effective credit control policies to ensure that the business maintains a healthy cash flow position.
- Critical examination of the business bank account to ensure that cash flow statements show the true cash position of the business.
Source Documents
There are three types of source documents that are produced in relation to sales transactions between the customer and supplier for the purposes of record keeping:
- purchase orders
- invoices
- credit notes
1. Purchase Orders
A purchase order is a document sent by the buyer to the seller when ordering goods or services. It contains the following information:
- buyer’s purchase order reference number
- description, quantity and code number of the goods
- signature of the person authorizing the purchase
- date of the order
2. Invoices
An invoice is a trading document, which is sent by the seller to the buyer, stating how much is owed by the buyer for a specified delivery of goods or services.
It should contain the following details:
- date of the invoice and tax point
- seller’s address, buyer’s address and the place where the goods or services are to be delivered (if different from the buyer’s address)
- invoice reference number, account number and buyer’s reference number
- VAT registration number (if applicable) of the seller
- description of the goods, the total quantity, the price per item
- and the total price with a discount if offered
- seller’s terms and conditions and payment date
3. Credit Notes
A credit note is a ‘refund’ document produced by the seller to the buyer, which reduces the original amount owed by the buyer. Credit notes are often agreed between buyer and seller, for example in the case where faulty goods are received. The credit note is usually produced after delivery of the goods or services but before these have been paid for.
Credit notes contain the following information:
- original reference number of the invoice
- reason why the credit note has been issued
- amount of credit that has been agreed
Credit Control Processes
As can be seen from the examples of source documents, the trade relationship between the seller and buyer of goods and services can be arranged as one of credit, i.e. a time period is allowed to elapse from when the buyer receives the goods until the goods are paid for.
Credit terms (if offered) are usually agreed between the buyer and seller at the outset of their business relationship and are stated on the seller’s invoice.
It is essential that an organization has an appropriate credit policy for its business as customers who do not pay their bills on time seriously affect the company’s cash flow position.
Factors Influencing an Organization’s Credit Policy
- Which customers should be offered credit terms?
- For what length of time should credit be offered?
- Will discounts be available for prompt payment?
- What collection policies should be used?
- What credit period and terms is the norm in this sector of the market?
Suppliers of goods and services will often wish to check the financial reliability of a potential customer before offering credit terms.
Checklist to test the financial soundness of a potential customer:
- Check with credit reference agencies such as Equifax or Experian.
- Request bank references.
- Examine the company’s published financial statements.
- Request trade reference statements from the buyer’s other customers.
Credit Control Processes
There are a number of effective techniques that can be used to manage credit such as: cash discounts, debt factoring and invoice discounting.
- Cash discounts. Offering cash discounts can be a way to encourage customers to pay their bills on time. However, this may have a negative effect in that the customer then expects a discount as the norm, with a subsequent effect on profit margins.
- Debt factoring and invoice discounting. These are facilities offered by third parties who manage trade debts and invoice payments on behalf of their clients. The third party offers cash advances to the client and in return, manages the collection of the invoice payments owed by the customer. The client pays commission and interest to the third party for this service. These facilities are especially useful for young or growing companies who may have cash flow problems.
Monitoring the Effectiveness of Collection Policies
Monitoring the effectiveness of your company’s collection policy can be found by using a simple ratio to calculate the average time it takes for your customers to settle their accounts.
Average Time for Account Settlement
Trade debtors
(Turnover) sales
x
365
=
average debtor payment period (days)
£458.3m
£2,059.5m
x
365
=
81 days
If your company offered a 90-day credit period to customers, then, clearly, the above figure of 81 days is in the target zone.
Bank Statements
Businesses monitor their cash position by generating and updating cash flow statements. The cash flow statement and forecasts must reflect the true cash position of the business – which must be updated from the bank account statements. The business bank account summarizes all of the cash movements between the business and its customers. Cash flow forecasts are needed to see if there is enough money in the business to pay bills and other outgoings.
